NEW DELHI, April 4 (Reuters) - Diversified Indian stock funds lagged the benchmark Sensex in March due to higher allocation to cash and exposure to mid- and small-sized companies.

Such funds posted an average return of 7.67 percent in the month, lower than the 9.1 percent gains the Sensex registered, data from global fund tracker Lipper, a Thomson Reuters company showed.

“Funds with higher cash exposure in the end of February probably missed out partially on the rally in markets in March and thus underperformed during the month,” said Dhruva Raj Chatterji, senior research analyst at Morningstar India.

Diversified equity funds had 7.82 percent of their assets allocated to cash as of end-February, their highest level since July 2009, according to Morningstar India data.

“Our data shows that the bottom ten performing diversified equity funds in March had an average cash allocation of close to 15 percent,” Chatterji added.

(For a category-wise table, click on [ID:nL3E7F40W7]).

Exposure to mid- and small-cap stocks, which accounted for more than a third of such funds’ assets as of end-February, also acted as a deterrent as such companies underperformed their larger peers in March.

The BSE Mid-cap index gained 7.8 percent, while the index rose 4.6 percent during the month.

Exposure to the capital goods sector, one of managers’ top bets in India which accounts for nearly a quarter of such funds assets, was unable to boost unit values as the sectoral index gained 6.7 percent and lagged the broader market.

However, banking funds remained star performers of the month, recording an average return of 10.5 percent, Lipper data showed.

The BSE Banking index rose 12.3 percent in March, on hopes that the Indian economy would continue to grow at a fast pace, and in turn boost demand for loans.

“It’s (the banking sector) the backbone of everything,” said T P Raman, Managing Director at Sundaram Mutual Fund. “With the infrastructure story gaining pace, the banks will have an increasing role to play.”

Indian fixed income funds that invest in government debt returned an average 0.62 percent, as the yield on benchmark 10-year bond fell three basis points in March.